House prices could halve in 'very severe scenario' where unemployment hit 17.7%

Thursday, 17 September 2020

First home buyers have had to mortgage to the hilt to get into a first home.

A steep rise in unemployment beyond currently forecast levels could cause an even more dramatic collapse in house prices, according to modelling by the Reserve Bank.

Banks would need a multibillion dollar bail-out if the Covid-19 pandemic pushed unemployment close to 18 per cent and stayed in double figures for four years, the Reserve Bank has forecast.

The bank forecast in August that unemployment would peak at 8.1 per cent triggering a 9 per cent drop in property prices “from peak to trough”.

But it has also modelled two “pessimistic scenarios” during which a rise in unemployment to between 13.4 per cent and 17.7 per cent could cause house prices to fall by between 37 and 50 per cent.

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That would trigger huge bad debts for banks.

The probability of those scenarios eventuating had reduced somewhat since they were originally developed in late March and early April, the Reserve Bank said in a report on Thursday.

But a series of further adverse shocks could see them “quickly return within the range of plausible outcomes,” it warned.

In the “very severe scenario” modelled by the Reserve Bank, banks would need a $7b bail-out in the third year of the crisis to stay afloat and keep lending, it forecast.

“Even though these scenarios are severe, they are not unprecedented internationally, and the economic costs of such bank failures are significant,” deputy governor Geoff Bascand said.

Governor Adrian Orr has frequently suggested Covid has been an illustration of why the central bank was right last year to require banks to build up their capital reserves in anticipation of a deep crisis.

Although some economists have been surprised by the way property prices have held up so far during the pandemic, the Reserve Bank’s scenarios imply price drops could become exponential if unemployment rose above a certain level.

The bank pointed to Ireland, where house prices halved between 2006 and 2012, as an example of that happening.

It said in its report that the onset of Covid had made clear to banks and regulators the importance of considering more severe “black swan” events in stress test scenarios.

Its overall assessment was that in the base “pessimistic” scenario, banks could survive on their own capital, but it would be a significant challenge to rebuild their capital buffers as the economy recovered.

Bascand said that also assumed banks would act rationally and that they could see how the crisis was going to play out which was “not the case in real time”.